Global Drinks Intel columnist Maurice Doyle looks at the thorny issue of pricing strategy in an inflationary environment.
Barely a day goes by without a new headline about additional cost pressures facing business. Wage inflation, increasing costs for raw materials, supply chain/transportation, energy, etc. Unfortunately, drinks companies are not immune to this nasty cocktail.
Drinks companies large and small are reviewing how to deal with this challenge. Larger companies are likely to be temporarily insulated on some cost increases through hedging, but this provides only short-term relief.
Essentially, there are three responses to these escalating cost pressures. Absorb the costs taking a margin hit. Mitigate the increases via savings elsewhere. Or pass them onto your retail/distributor customers via price which may ultimately be passed onto the consumer.
Much depends on whether you believe the cost pressures are temporary or permanent. This is especially important for those customers that allow only annual price increases as you get one chance a year to get it right. If you view the pressures as temporary, then not taking a price move becomes easier to justify. Remember though, there will always be a reason not to take a price increase. Simply absorbing cost increases will lead to margin erosion. This reduces shareholder value and ultimately is a failure of leadership.
If you can identify savings elsewhere which have little impact on the consumer experience then you should implement them. I would question why you are incurring these costs normally but that is another topic. However, given the extent of the current cost pressures, it is likely to be challenging to find compensating savings. This leaves pricing.
Pricing is a strategic choice for any organisation, albeit an emotive and often misunderstood one. I have worked for beverage companies operating in low and high-inflation environments. The pricing tactics may change, but the principles remain similar.
The starting point must always be the consumer. In practice companies often focus on the retailer/distributor reaction as it is most immediate and the most directly painful! Like many, I have my pricing scars. Being asked to immediately leave one international retailer when I suggested an annual price increase comes quickly to mind!
Brands of course cannot control the final price to the consumer, but they must have a recommended consumer pricing strategy. It is the job of drinks businesses to create greater desire for their brands and enhance their value perception. The role of pricing strategy is to allow you to realise all the consumer value created.
Price is processed by shoppers as a key driver of quality perception. Many shoppers are price sensitive but fundamentally more are value sensitive. This is especially true in beverages, where image plays such an important role. The more differentiated and relevant your brand, the less price sensitive shoppers will be. Weak brand equity (and weak trade leverage) makes moving pricing forward even more difficult.
Now is the perfect time to examine the effectiveness of your marketing investment. This can have only one of two objectives. It should either build equity or drive transactions. If it is not achieving either goal, you should not be doing it. Both objectives have important roles in times of cost pressure. You need to monitor the split between equity building and transaction driving investment – you don’t want the latter to take an increasing majority of the investment.
Established brands will either follow a high price differentiation or low-cost leadership pricing strategy. The more your brand relies on price currently will influence your ability to pass on price increases. It is more difficult for value brands to pass on increases than premium ones. Remember though there is a word for something that sells exclusively on price – it is called a commodity.
For early life-cycle brands, the situation is different. My advice to startups is to get pricing right from Day 1, beginning with the recommended consumer price. Ensure the trade price is consistent and defensible across customers/markets as you expand. Sometimes founders believe they can move towards higher pricing when their brand is bigger. This rarely works in my experience. When a brand gets bigger, it becomes significantly more painful to take a price increase.
There will inevitably be internal debates about the impact of taking a price increase even with cost inflation. How will it affect our competitive position? This is a valid concern but against that shoppers and retailers are currently seeing price increases across many categories. That makes accepting a price increase a little easier. For spirits companies, demand is generally buoyant currently, especially if you have exposure to the US and Chinese markets. It is less difficult taking a price increase when this is the situation versus falling demand.
Price increases should be transparent and defensible, in inflationary times or not. If retailers can see a clear justification for a price increase and a benefit for them, then the conversation will be easier (but rarely easy). Someone in head office wanting an increase is not enough of a justification!
There are other ways to increase margin than headline price increases. Interrogating your complete value chain becomes even more crucial in a high inflation environment. From experience, the area between gross and net pricing can be as significant as A+P investment but rarely receives the same scrutiny. Managing your discounts/promotional exposure better can be extremely beneficial. Tightening up your discount authorisation procedures can also be a good way of improving margin. Finally, positively adjusting your size/SKU mix can drive profitability – too many brands incentivise shoppers to buy lower-margin formats.
Especially in inflationary times, it is important to incentivise your sales/marketing teams on revenue (ideally revenue per case) over volume to encourage delivery of price increases.
In summary, drinks companies face difficult decisions due to the significant cost pressures they are experiencing. The choices they make will shape their short-term and longer-term performance.
Volume is important. Revenue is more important. Profit is most important. Cost increases impact profit if not addressed. That is why Goliaths like Coca-Cola and PepsiCo are already passing on costs in the US. They will not be alone.
Maurice Doyle is the founder of Generous Spirits, which supports beverage companies to successfully build and scale their brands. Doyle has more than 25 years’ leadership experience with Bacardi, William Grant & Sons and Suntory Beverage & Food Europe.
Contact him at maurice@generousspirits.com
